Welcome to the weekly macro column of Coindesk, where analyst Omkar Godbole writes on his observations and his macro analyzes on the larger markets. The opinions expressed in this column are not investment advice.
A pair of major currencies, which is barely considered volatile, now competes with the performance of the notoriously explosive – unimaginable bitcoin prices, right?
No more.
In June, EUR / USD, the most liquid FX pair in the world, increased by almost 4% to 1.1786, surpassing bitcoin
Gain of 2.4%. Remarkably, the two assets are almost elbow and the performance of the year up to date, each greater than 13%.
Some observers believe that EUR / USD always has room to run higher, a positive sign for European stabbed, which have already benefited from the push of the currency.
“EUR / USD could be confronted with resistance probably in the 1.22 / 1.23 field,” said Marc Ostwald, chief economist and global strategist at ADM Investor Services International, explaining that accent is on Germany which retains its debt braking, which is considered “positive growth by most people”.
German exceptionalism and frightening US budgetary
The term American exceptionalism – the relative attractiveness of dollar assets, supported by the budgetary expenses of the Biden era – has historically helped the greenback. However, this story now shows reversal signs under the second term of President Donald Trump. The concerns concerning the expansion of budget deficits and the outbreak of the detention costs of debt have triggered what some now describe as a budgetary fear “.
Now the account of exceptionalism could move to Germany.
Indeed, at the beginning of this year, Germany announced a historic budgetary plan including an exemption from defense expenses (more than 1% of GDP) From the debt braking, an infrastructure fund of 500 billion euros to be deployed over 12 years, and 100 billion of which will be immediately transported to the Fund transition.
The remaining amount concerns additional investments in infrastructure, with 300 billion euros for the federal government and 100 billion euros for state governments. Finally, the plan will allow governments of states to carry out annual deficits up to 0.35% of GDP.
The direct impact of the tax package on German GDP should be felt from next year, and it should be sticky beyond 2027, with positive effects for other countries in the euro zone.
This now changes the conversation into European assets, rather than we
“The initial condition has been a huge overweight in USD and assets, but now it looks like an allocation of European actions, with Germany intensifying defense and infrastructure expenses,” said Marc Chandler, chief market strategist at Bannockburn Capital Markets, in an email.
Political uncertainty
The emphasis on growth potential explains why the American-German yield (rate) The differential, as an exchange rate indicator, fell to the rear burner.
The graph below shows that the historical positive correlation between the EUR / USD and the two-year German return on German obligations broke down since the end of March.
In addition, higher yields in the United States no longer represent a positive economic perspective but are a necessity to finance deficits.
“The dollar may seem decoupled from prices, but I think that another way to frame it is that the United States must offer a higher bonus to compensate for the uncertainty of politics and the apparent desire of a lower dollar,” noted Chandler.
Rate prospects promote EUR
A potential offset in the differential account of the yield gives the euro under the spotlight. Market players are preparing to return to fundamental principles – in particular tariff differences – but prospects may not increase for the greenback.
“To a certain extent, the differential prospects of rates for EUR / USD are not favorable to the USD, if it is assumed that the ECB is largely carried out with rate reductions (maybe one more)While the Fed may well reduce rates up to 125 bps in the next 12 to 18 months, if US growth continues to be slow, “said ADM OSTWALD.
The European Central Bank (ECB) made eight quarter -point discounts in a year, but the euro joined the US dollar. From now on, the emphasis will be placed on the potential reductions in federal reserve rates. So far, Powell has held stable rates at 4.25% despite President Trump’s repeated calls for ultra-basic borrowing costs.
In other words, the rate differential is likely to expand in favor of the EUR.
Need higher FX FX coverage reports
Historically, the USD has offered natural coverage to foreign investors in American actions.
So, of course, as a positive correlation between American shares and the dollar, European retirement funds – which represent almost half of foreign assets in American stocks – and other investors are forced to increase their FX coverage to protect the portfolio yields against the low dollar. According to market observers, this FX coverage strategy could continue to propel the euro higher in the short term.
Let’s put the coverage strategy in context. Imagine a European fund with $ 10,000 in investments in the United States if the US dollar (USD) is weakening compared to the euro (EUR)The fund’s investment loses value when converted to euros.
To cover itself against this exchange risk, the fund could consider the coverage of this investment by taking short bets on the dollar via attackers, term contracts or options, adding to the lower dollar momentum.
“Using the monthly Danish pension flow data as a European indicator, April saw a higher peak in the FX coverage ratio of 61% in January at 74% in April. We have already seen 80% more consistent FX coverage for all European investors, who will naturally see EUR sales on the flow of news fades on a daily basis until these flow peaks. We are not there yet, but we are much closer, “recently explained Jordan Rochester, head of FICC’s strategy in Mizhou.
According to financial analyst Enric A., less than 20% of European institutions currently cover their exposure to the USD, and they will have to do more to stabilize portfolios, which could lead to a lower USD dynamic.
“Higher coverage ratios = more EUR purchase, more USD sales,” said Enric on LinkedIn.
And to top it all, the coverage of the funds of other regions may have had the same effect. Chandler cited BIS data while highlighting the coverage by Asian funds.
Conclusion: While macro narratives evolving towards potential dynamics of the softening and coverage of the United States exert pressure on the greenback, the EUR / USD can remain dynamic despite the opposite winds of the growth of the euro zone.
Find out more: is it time to reduce, cover and diversify exposure to the USD?
